Earlier this morning the CEO of Coinbase, the largest US based and regulated digital asset exchange, published a series of tweets. He stated that the soon to be leaving US Treasury Secretary, Steve Mnuchin, is trying to pass a harsh implementation of the FATF travel rule before departing from the office of Secretary of the Treasury.
What is the FATF imposed travel rule? First, the FATF. The Financial Action Task Force is an intergovernmental organization founded in 1987. It was an initiative by the G7 to combat money laundering. Currently every major economy in the world is a member of the organization. The FATF published a report last year stating the worry of the member states on the usage of cryptocurrency for illicit activity. To combat this, the FATF proposed guidelines in a report published in 2019. The guidelines proposed by FATF included the so-called “travel rule”. The travel rule requires virtual asset service providers (VASPs) such as crypto exchanges to collect and transfer customer information during transactions. Between exchanges themselves this is seemingly easy, various projects (including an investment of ours Shyft Network) have been building infrastructure solutions for this.
However, the big question mark remained around the transferring of assets towards self custodied wallets. This is the case when a user withdraws from an exchange, towards a wallet owned and held by the customer itself (so called self-hosted wallet). In some countries, the Netherlands and Switzerland for example, this rule has been implemented rather harshly. Users that want to withdraw to a self-hosted wallet have to confirm they own this wallet. In the Netherlands this is done by providing a screenshot to the exchange. There is currently a trial against the Central Bank of the Netherlands by Bitonic regarding this matter, mostly pertaining to the actual effectiveness of the measure.
Armstrong is indicating that the leaving US secretary of treasury is also on this more harsh path. The regulation put forward would require VASPs to verify the identity of a self-hosted wallet owner before sending assets to that wallet. At the surface this seems like a good idea, however it is also very impractical. If a particular user withdraws to a smart contract for instance, identifying the owner of that address is impossible since there is no owner. In addition some recipients, especially in the third world where actual crypto usage is rising, might not have sufficient ID data. Therefore the way these guidelines are implemented or would be implemented are seen as harming innovation, while not actually punishing the bad actors.
After Armstrong published his series of tweets, the price of Bitcoin went down, although causation remains difficult to estimate especially after the steep run up during the last few weeks. However, this could be an indication that the industry is not comfortable with stricter regulations from the US. Another angle would be that a more compliant industry is both comfortable for participants such as ourselves and also enables easier entrance of compliant participants and other crypto products. This was already seen back in 2018, where various Bitcoin use-cases were presented over time in an article by Nic Carter and Hasu. The grey area (darknet markets, illicit activity) is already diminishing its importance while the uncorrelated financial asset use-cases (in which financial institutions are interested) are increasing.
How the travel rule is exactly implemented by the US is unclear for now, as Armstrong seems to front run the harsh implementation by Mnuchin. If he fails, it could lead to two markets. Those of compliant, non-tainted Bitcoin which are all KYC’ed throughout their entire lifetime. And another market section for tainted Bitcoin. These might even differentiate in price. However, one thing to note here is that the US government itself does not seem to be worried about “tainted” Bitcoin. This is shown by their previous efforts to auction off confiscated Bitcoin, indicating that they do view Bitcoin as fungible. This makes the splitting into a “tainted” and “untainted” market unlikely in our opinion.
Another important thing to note is that these regulations are coming from a departing secretary of the treasury. It is perhaps even more important to get an indication how the next secretary of the treasury nominee views the FATF guidelines. While it is impossible to get an extensive answer to this the rumoured candidate, former FED Chair Janet Yellen, has expressed her views on Bitcoin quite clearly in the past. She stated the FED had no role in regulating it, she thinks it is used for illicit activity to some extent and that the US regulators should not stifle innovation. From this we can’t, at this time, draw a solid conclusion as to what her views are.
The general regulatory sentiment has been rather positive over the past few months. From US banks being allowed to custody digital assets, to the European Commission releasing a comprehensive regulatory framework. We stand behind regulations that increase the protection of the crypto users as well as the investors. We believe that the above mentioned changes will not reduce illicit activity while introducing an additional hurdle for adoption. Therefore, we hope that the rumoured regulatory framework will not be implemented in the current form. We are convinced that the regulators can find a solution that balances preventing illicit activities, which we deem important, without slowing down innovation.